Chris Lee & Partners Ltd

Taking Stock 27 February 2020

Chris Lee writes:

MOST of us know what makes us feel good about being a New Zealander.

It might be Richie McCaw or Laura Langman, holding up a world cup, Kane Williamson being dignified in defeat, Jacinda Ardern displaying social intelligence or Mark Pennington winning world gold medals for excellence in office furniture design.

It might also just be looking down from a hill beneath the Southern Alps, gazing at 560 cows grazing from green pasture, patiently waiting for the signal to wander up to the milk shed while the farmers close gates, use the effluent to fertilise empty paddocks, or assess soil moisture levels, or view  MetService forecasts, as they go about their business.

What does not bring a smile to my dial is reading the propaganda and worse, lies, used to support the woke movement which wants to butcher the nature-provided advantages that underscore living standards in New Zealand.

The picture of beef farmer Sian Elias' cattle being allowed to wander into a lake might provide graphic support to the movement which wants to reduce dairy farming but, as always, there is another story to be told that might provide balance.

Last week I visited three farms on the edge of the Mackenzie country near the quaint town of Fairlie, on the road to Tekapo and Queenstown.

Fairlie is probably best known for its famous pie shop, where you queue to choose pies of gourmet quality, with fillings of salmon and brie, or roast lamb, mint peas and roast vegetables, or pork, crackling and apple, amongst others.

A successful couple invited me to visit and learn of their farming philosophy.

Put simply, they practised natural dairy farming, focusing on nurturing the pasture and controlling input costs, neither stretching the ability of the paddocks to grow pasture, nor pushing the cows’ health in pursuit of more milk solids.

They had proved that their annual returns were better by far than comparable returns, where the competitors spend heavily to increase output, and thus become reliant on permanent high milk solid prices.

They had expanded by being able to borrow and service debt to buy land whose price fell during the periods when milk solids were cyclically at lows. Banks like lending to farmers who service and reduce debt even in the tougher years.

If you can make a living from low prices, you create handsome, useable surpluses when prices are high.

If you use surpluses to reinvest in pursuit of ever more output, then your input costs and capital expenditure puts you on a treadmill that seizes up when prices stall, as they do cyclically.

To farm well, you do not need all the bells and whistles; you do not need a $300,000 tractor to cart your silage across a paddock. A second-hand ute does the job well. Capital is better used to enhance nett revenue rather than show off new toys.

Profits should be used to reduce debt or to obtain synergies by expanding, but only at a price that produces nett gains.

The admirable couple started with their equity in modest town apartments and from that base have built six farms, including four dairy farms, that provide excellent lifestyles for their farm managers, their sharemilkers and their own family. The superior returns attract good people and provide them with rewards that relate to their contribution. Good and happy staff and managers build a sustainable future.

Where else, but in NZ, could one start with ‘’zippo’’, work hard, become sharemilkers, save by frugality, and within 20 years own thousands of acres in a beautiful part of the world?

The couple bought one nearby block of roughly 400 hectares that had provided a modest living for one sheep-farming couple. It now provides four families with their homes, good income, good prospects and a lifestyle that includes travel and family time.

The key point of difference has been ‘’farming the pasture curve’’, rather than trying to push nature to produce more pasture, and grow milk production with imported feed, in pursuit of higher gross, but not nett, revenue.

The farms looked great. The farm managers were informative and unstressed, and the land viewed from its highest point (500m above sea level) looked wonderful, despite the absence of any irrigation. There was no scrub or gorse in sight. The water in streams was drinkable.

As a model of dairy farming, it was clearly from the Kiwi drawer, not some fancy European or American drawer. In Europe, dairying is characterised by inside living, bought-in feed, subsidies and ridiculously (for Kiwis) inflexible lifestyles.

In the USA, cows are seen as short-life, force-fed machines, expected to produce milk for 18 months, dried off for three months, back at work for 18 months, and then sent off to the abattoir.

At the Fairlie farms, a cow died recently, aged 17, having had 15 calves and having had an average holiday each year of 65-75 days, never kept indoors, never force fed, a ruminant wandering around a paddock, producing milk from grass, probably airing her complaints about the All Blacks’ loss to England with her mates across the paddock.

The intensive, animal-unfriendly practices are neither desired nor needed in New Zealand.

I left the paddocks understanding that between how politicians, bankers, environmental extremists and the general media see dairy farming, and how the rural towns and the farmers see dairy farming, there is a chasm.

Some imagine this chasm houses empty rivers and streams, the water ‘’stolen’’ by irrigators or polluted by run-off or effluent.

These people imagine never-ending excessive applications of carcinogenic phosphates, imported from Morocco or Russia, applied to maximise pasture in the short-term and they imagine that the demise of Malaysian and Indonesian native forests follows the NZ importation of ever greater supplies of palm kernel, used to overfeed cows in pursuit of liquid gold.

They see farmers as indifferent to rivers and streams, short-term in their exploitation of pastureland and animal health, greedy people, seeking their millions, selling out to corporations and the Chinese.

Some facts:

1. The NZ system works because of our weather, our open spaces (grass fed cow’s milk will soon attract global premium pricing), our sharemilking, which creates a structure for hard workers to progress, and the co-operative model. As every farmer enjoys the same price, there is co-operation and information-sharing that occurs in very few business sectors.

2. Irrigators may not take any water from rivers or streams unless the authorities are satisfied the take-off will not affect the health of the waterway. Low rivers equate with low rainfall, NOT irrigator abuse.

3. Farmers have the most pressing need to preserve animal health. It would be a moronic farmer who disregarded animal welfare.

4. Farmers are not cow cockies. They are more knowledgeable of meteorology, currencies, economics, soil health and animal health than any other grouping. Their breadth of knowledge far exceeds that of their critics, I suspect.

5. Farms use technology far better than most. Probes measure soil moisture levels and message farmer cell phones with the need for more or less water. The probes measure the ability of the soil to absorb effluent. No one sprays effluent on sodden paddocks and allows run-off. For heavens’ sake, water, pasture and animal health are the key determinations of long-term survival.

6. The rural sector produces not just a handsome percentage of GDP and exports but is undeniably linked to tourism, the current star performer in our economic model. An extraordinarily high percentage of tourists arrive here because of our farming status and farming standards.

7. Farmers do get out of bed early. They do not struggle up at 10am to photograph themselves modelling jewellery or clothes, in the modern-day quest of being a social influencer. They create essential products, jobs and wealth. They deserve our gratitude, not our scorn. They deserve a far higher level of understanding than might be found in banks, where quarterly profits equate with meritless bonuses.

If you struggle to absorb this, drive down from Geraldine to Fairlie and ask someone in the Fairlie pie shop to find you a local farmer to show you around.

You may find a farmer in the shop, ordering a salmon and brie pie to give to his wife, after she has mucked out the milk shed.

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Johnny Lee writes:

Reporting season has almost concluded, with most of our major companies now up to date in their financial disclosures.

While the majority of companies were reporting growing profits, with a few growing dividends, one common theme across these reports were increasing costs – both regulatory and general expenditure such as labour, rent and insurance.

Company outlooks were almost universally positive, as they so often are, but almost all expressed some concern surrounding the Coronavirus. This topic has been thoroughly canvassed across the media, and fears around this have been blamed for a drop in share prices over the past few days.

Initial impacts seem to suggest a reasonably large short-term impact to our economy, which will be evident over the next few months as the banks conduct surveys of business confidence and GDP figures are announced. Already, the likes of Auckland Airport and Air New Zealand are signalling short-term downgrades, while stories of reduced capacity from Chinese ports is hurting the likes of Port of Tauranga and Napier Port.

For some investors, this may present buying opportunities. The ports have long been considered defensive stocks, due to our nation’s geographical isolation, and the reliance on importing and exporting this creates. Share prices for this sector have reflected this defensiveness, leading to yields that may be off-putting for income investors.

However, such a strategy relies on the impact of Coronavirus being short-lived. Increasingly, it appears that the disease is continuing to spread, even as entire cities face quarantine efforts in a bid to halt the contagion.

Investors would be wise to continue monitoring these developments.

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Heartland’s half-year results, published last Wednesday, will have pleased long-term investors of the company, showing a modest increase in both profitability and dividend.

The increase in dividend comes at a time when many banks are choosing to temporarily decrease their dividend payments, as regulators cast a sterner gaze upon bank conduct and anti-money laundering obligations.

It marks the third dividend increase in four years.

Nett profit after tax rose 20%, while impairment expenses fell. As Heartland previously forewarned, costs rose, while margins slightly fell.

All told, Heartland is growing, dividends are rising, while the costs of doing business, especially in the regulatory space, are climbing.

Globally, other major financial institutions are finding business equally difficult. HSBC has announced its intention to gradually reduce its workforce by up to 35,000 people. The likes of UBS and Goldman Sachs have also been gradually ‘’reducing headcount’’, as well as tightening their focus on to areas where it sees higher growth.

The likes of Kiwibank and ASB have already reported reductions in nett profit.

Heartland appears to have found a niche with its products that allows it to continue its growth trajectory in what is undoubtedly a tough environment for traditional banks.

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Amid the flurry of news made by our listed companies during reporting season, one often overlooked sector is the Listed Property Trusts.

As the bulk of revenue from these companies is in the form of long-dated and predictable lease agreements, revenue is fairly predictable. Likewise, costs are reasonably certain, with the likes of interest costs and administration costs being controllable and transparent.

These factors are some of the reasons why Listed Property Trusts are often used as a vehicle for investors wanting to achieve better returns than listed bonds, while not being subjected to the same volatility perhaps seen from the broader share market.

Over the past month, shareholders may have noticed a sudden spike in the price of some of the listed property trusts, with some dividend yields now beginning to approach 3% after tax. Share price gains are outmatching growth in underlying earnings and distributable income, although the likes of Vital Healthcare and Precinct Properties have publicly stated their intentions to lift distributions made to unit-holders over the near term. Goodman Property Trust is another company that is actively building or acquiring assets.

All of the listed property trusts have enjoyed falling interest rates which underpin rising property prices and thus rising rents. Almost all of them are actively growing, either building new facilities, or seeking new opportunities to buy assets to grow returns.

Vital Healthcare, for example, is looking to purchase land for leasing to existing aged care operators in both New Zealand and Australia, with the intention of introducing very long-term leases to those operators. It believes the potential returns in this sector of real estate will outperform the likes of hospitals and clinics.

It may be prescient. Retirement villages are permanent and make their money from constant property turnover, not from the value of land ownership.

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Shareholders of Augusta Group may be puzzled to observe a gradual increase in its share price, to levels now above that of the takeover price of $2 a share.

The answer lies in the second option afforded to shareholders – being the option to accept a number of Centuria shares in lieu of the cash payment.

Centuria shares have been touching record highs in recent weeks, prompting shareholders to consider the option of accepting the shares, or simply selling their Augusta shares on market to those more interested in holding Centuria scrip.

Accepting the $2 per share is, at this stage, the worst option available to shareholders. Those uninterested in holding shares in Centuria will almost certainly be better off selling the shares on market, based on current pricing.

The situation arose because the price for the Centuria share offer, and therefore the number of shares allotted per Augusta share, was set in January, instead of a timeframe closer to the implementation of the takeover.

Augusta shareholders wanting to discuss their options are welcome to contact us.

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EBOS’ share price responded well to its news release, which reported increasing profits and yet another increase in dividend.

The company confirmed it is sitting on headroom of about $350 million for potential acquisitions, although its current focus is improving efficiencies and exploring opportunities from its recently acquired medical devices division.

EBOS seems relaxed at the prospect of competition from the likes of Amazon, believing that regulatory requirements will provide a strong barrier to entry, while its existing relationships put the company at the dominant position in the markets it operates in.

Shareholders should be pleased with its continued strong performance.

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TRAVEL

Edward will be in Nelson on 3 March, (4 March is now full) and in Napier in April.

Johnny will be in Christchurch on 25 March.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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Taking Stock 20 February, 2020

IF one has a family trust and one responds to the signals from politicians, this may be the last year of the trust.

By 2021, most family trusts are likely to have been dismantled, the assets distributed either to the settlor or to the beneficiaries.

The merit of most trusts will have become negative.

By year end, no trustees of a family trust should be unaware of the changes in legislation that have negated the principal benefits of a trust.

If we cast our minds back to the 1980s and 90s we will recall that in those years we had a number of parties frenetically advocating or advising on trusts. People like Douglas Lloyd Somers-Edgar at Money Managers, Martin Hawes, Ross Holmes and countless lawyers wrote books about trusts or advocated them on radio shows and at seminars.

The three principal benefits were said to be:-

1) The ability to hide income, thus avoiding the National government’s surtax on the NZ pension, a tax that clawed back the pension from those with even modest levels of other income;

2) The ability to hide assets and income in order to access a government subsidy for those who lived in rest homes;

3) A legal structure to avoid punitive death duties.

Very little discussion focused on the real value of a family trust, which was, and is, to divert assets from a future estate and thus avoid family squabbles or judicial interference with the final wishes of the owner of the assets.

The family farm, business, home or financial assets could be placed with the trustees, effectively indefinitely, meaning the trust could continue to set the rules, rather than have those rules transferred to an estate, where any scorned beneficiaries could mount a judicial challenge.

That benefit remains intact but it raised problems which I will discuss shortly, the elephant of all problems being the greed and self-focus of all the trustee companies licensed to provide the administration of trusts.

The number of trusts in existence in New Zealand will now begin to dwindle for three logical reasons:-

1) Even the most cynical of advisers/lawyers will not be seeking fees by designing trusts to avoid asset or income testing. The Crown and the tax authorities routinely regard ‘’trust’’ assets as the property of the settlors and beneficiaries and disallow subsidies for those who might have access to trust assets.

Death duties are now rated zero. There is nothing to avoid.

2) New law will require trusts to disclose trust assets and income to all potential beneficiaries, thus ending the doubtful value of ‘’hiding’’ wealth from one’s ultimate heirs and beneficiaries. The quaint notion of not revealing wealth to one’s offspring is officially anachronistic.

3) The governments of the world regard a trust as a device that is widely used by money launderers and other evil forces.

There will be increasing pressure on trustees and beneficiaries to comply with invasive anti-money laundering protocols.

Indeed, some intermediaries required to apply AML protocols will not act for trusts involving overseas residents. The administration and the risk far exceed the value.

So only the most logical and necessary trusts should be in existence by 2021.

Trusts will be dissolved cheaply and efficiently. Law firms will dissolve them at minimal or even no cost, assets like shares and bonds simply being transferred to the settlors or the beneficiaries, properties re-registered in the appropriate names.

The elephant in the room is the problem of escaping from inappropriate trustees, an issue for those trusts that do have a logical existence and want to continue.

I refer here to legitimate trusts that, for example, define assets that may have preceded a second marriage or may be intended to protect needy beneficiaries, such as the disabled or afflicted.

At issue is the now absurd involvement of trust companies, the largest of which is now Perpetual Guardian Trust (owned by a UK asset arbitrageur), the Public Trust and Trustees Executors, (owned by John Grace, an American investor).

The trust companies today are licensed and regulated by the Financial Markets Authority, but that has done nothing material to alter their self-serving behaviour that has made me so critical of trust companies.

Perhaps this behaviour began when the Public Trust was challenged by the Crown to make profits, rather than just supply a public service to those who would not naturally engage a lawyer to design a trust or an estate, and outline an administration programme to ensure the trust was managed sensibly.

As the Public Trust degenerated into corporate aspirations, the other trust companies, led by NZ Guardian Trust, accelerated a pursuit of fast profits. These came from absurd fees and morally bankrupt practices, like encouraging dying people to form testamentary estates with a corporate life of decades, contractually feeding years of fees to the trust company.

Presumably it was this focus on profits that led to the loss of the more competent (and expensive) staff, in favour of a dumbed-down service.

Simultaneously, we witnessed a surge of corporate trust interest in administering the deeds of finance companies and managed funds.

High fees did not equate to administrative excellence or devotion to duty. For those in doubt about this, read my book The Billion Dollar Bonfire!

Well do I recall the former employer of one high-profile corporate trustee describing his previous manager as being suitable for no more complex task than an accounts payable clerk.

Competent and ambitious financial market participants would regard trust companies as the bottom rung of any ladder.

The hungriest of the trust companies now is Perpetual Guardian Trust, owned by ex-Macquarie executive Andrew Barnes, who arrived in New Zealand a few years ago after leaving the millionaires’ factory, as Macquaire was disparagingly named, to take on governance roles with a fund manager in Australia.

When this company made unwise investments, Barnes, to his credit, resigned and sought a new home.

New Zealand allows businesspeople to obtain residency and citizenship if they invest large sums here.

Barnes bought Perpetual Trust from George Kerr, himself an asset arbitrageur with a colourful background. The two knew each other well.

The Perpetual deal was convoluted. Indeed all its internal circuitry perhaps is still not unentangled, Barnes and Kerr both commencing and withdrawing legal cases against each other.

Barnes tried to list Perpetual after buying NZ Guardian Trust and a minnow or two (Covenant was such a minnow) but the capital market leaders in New Zealand rightly judged that PGT was more suited to a private trade sale.

Barnes announced triumphantly that he had sold PGT to two very young Australian lads, neither of whom had relevant experience, for an astonishing sum of around $200 million, a figure perhaps three times the value I could see in PGT, a company I regarded as a poor performer in a sunset industry.

Unsurprisingly, this deal collapsed, so Barnes was left with a debt-funded purchase of a company that had no obvious appeal. He has since described his position then as uncomfortable.

But in came the canny Direct Capital owner, Ross George, who became a half owner of PGT at a price that George would have seen as credible. The deal was structured as a loan convertible to shares, on George’s terms.

PGT remains the biggest in its market, by far the most expensive with its fees, but celebrated for its discussion of the four-day working week, and its linking of work hours to productivity.

As an example of its fees that I regard as excessive, it charges $22,500 per annum to manage a $1million estate, according to its website. The Public Trust’s fees would be less than half of that and are themselves excessive.

PGT also sought to innovate, aspiring to create efficiency by sending its clients’ wills and trusts to the ‘’cloud’’, enabling digital signatures to affirm updates to documents.

The law did not and does not allow such documents to be altered by digital signatures so this campaign may have subsided.

I have not observed any trust company providing as much trust administration expertise as I would expect of a trained lawyer, nor have I seen any lawyer’s bill being anything like the size of trust companies’ bills.

In my view, those who allow trust companies to administer wills or estates are simply throwing away money that should go to beneficiaries.

So in 2020 I expect change to be game-changing. Many, probably most, family trusts should be unpicked. A competent lawyer could oversee this at minimal cost, hundreds, not thousands.

Those trusts that should remain intact need to review the trustees and in my opinion would be likely to replace trust companies with a better and cheaper alternative.

A trust or estate managed by competent family or friends, perhaps with an obligation to consult a lawyer or accountant, would find annual savings that over a decade or so might be in the tens, or even hundreds, of thousands.

Trust companies would then be seen as being in a sunset industry, as I surmise.

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ANOTHER sunset industry is that routinely described as Peer-to-Peer (P2P) lending.

As is the case with trust companies, the demise of this sector has been frequently discussed in Taking Stock.

P2P was a product that grew out of technology as a solution for those who could not borrow from the traditional sources of lending, such as banks, finance companies, credit unions, family and friends.

It was seen as a way of reducing bank intermediation costs and of cutting time delays for borrowers.

A P2P company would use a matrix of data to assess the creditworthiness of the borrower, would allocate an interest rate that represented the perceived risk, and then allow those with money to fund some, or all, of the loan, charging a modest fee for the intermediation role.

The problem I foresaw was the impossibility of assessing and pricing risk accurately.

Like other dinosaurs from the banking practices of the 1970s and 80s, I knew the irreplaceable value of eyeball contact with potential borrowers and recalled the techniques used to filter out tall stories.

Matrix lending supposedly charges a premium to cover inevitable bad debts, just as bank credit card loans demonstrate.

I am certain that the individuals funding P2P lending would never easily accept bad debts.

The concept was interesting but would fail, at least in New Zealand, where trust is still highly valued.

Last week, Harmoney, the P2P market leader, acknowledged that the experiment had failed.

It would now fund these matrix loans with institutional money sometimes also called Other People’s Money.

As the institutions have or should have vast capital, no investor ever has to recognise a bad debt personally.

So the flawed project (P2P) is ending.

My guess is that the next projects to fail will be the group funding sites, where people seek to raise money through loose concepts like crowd funding, and pledges of money to help those who have had bad luck.

The crowd funding of those who want to fund their shoe shops with Other People’s Money (OPM) is destined to come under pressure in the next business cycle. The concept is based on caveat emptor – buyer beware (at your peril).

The pledging of money to help others will always be a practice that is regarded warmly by New Zealanders but the administration of such a fund should always be audited and priced minimally.

In the past, the churches provided this redistribution of charity, with very little intermediation cost.

Churches may not be completely transparent, but the likes of charities and churches are unlikely to invite into their congregations those who are looking to make their living as a middle man, intermediating OPM.

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NO subject arises more frequently, day to day, than the end-play of the Coronavirus.

Naturally, everyone who has read official or social media comment will have a view on how this virus might affect us.

Those who currently are simply being prudent will be reviewing their investment strategies and portfolio to ensure they can cope should the outcome be as dramatic as social media is forecasting.

A sensible position is to ensure enough cash is held to avoid the obligation to sell any securities in the midst of any group panic.

Trimming off enough cash to meet a year of needs seems to be a cautious but not extreme position.

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AUGUSTA enthusiasts have a rare opportunity to enjoy a free lunch.

For years, Taking Stock has advocated that the real jam in Augusta’s property syndication business was reserved for the owners of the funds management business. The property syndicate investors took a risk to get a return but the ticket clipping for the managers involved virtually no risk.

When Centuria arrived from Australia, it had its eye on the ticket clipping and bid to buy out Augusta for $2 cash per Augusta share or a fixed percentage of a Centuria share.

The Centuria share price has risen significantly so the $2 cash offer is now obsolete.

Canny Augusta shareholders can sell on the open market for much more than $2.00, or they can accept shares which seem to be rising in value.

Those who are cautious about Australian buyers of our funds management businesses can enjoy a free lunch, selling at a cash price that does not rely on the unknown forces that have lifted Centuria’s share price.

Free lunches are rare.

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TRAVEL

David Colman will be in Palmerston North on 26 February, and New Plymouth on 27 February.

Mike will be in Auckland on 25 February, Hamilton on 26 February and Tauranga on 5 March.

Edward will be in Nelson on 3 March and in Napier in April.

Johnny will be in Christchurch on 25 March.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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Taking Stock 13 February, 2020

Johnny Lee writes:

February is now in full swing, with reporting season underway for most of our major companies.

January seemed to pass in a flash. Markets were strong for most of that month, with most of our major companies enjoying a successful holiday season. This ended with the developments surrounding the Coronavirus, which continue to consume media attention and grip financial markets.

Concerns around the virus have led to wild swings in some of our largest shares, with the likes of Auckland Airport and Port of Tauranga seeing panic sellers, and bargain hunters trade stock at prices far below recent levels.

Longer-term investors will not be panic selling, but bracing for the situation to worsen before improving. Some may even consider topping up their holdings, depending on the discount. Those with a longer term view have the luxury of riding out temporary volatility.

Reporting season will introduce more volatility, prompting some to sell out and some to buy in.

Shareholders of Heartland Bank will have the 18th marked in their diary, as the company presents its half year results to its owners.

Shareholders would have noticed that the price has been gradually ticking upwards over the past month. Heartland's own forecasts have been for costs to have risen, as it invests in both its reverse mortgage and ''O4B'' divisions. O4B is the Open for Business loan product for small businesses. Compliance costs are also forecast to increase.

An update around its capital requirements may also be forthcoming. Heartland's response to the updated Reserve Bank Capital Adequacy Framework left it with plenty of options, either issuing debt, equity or making adjustments to its dividend policy.

If Heartland is announced as a buyer of UDC Finance, Heartland may take the opportunity to raise additional capital, which may in turn lead to a very short-term fall in share price. The timing of this may come shortly after the announcement.

Vector Limited reports on the 25th, which should include an update to the review of its dividend policy. In November, the Commerce Commission released its determination in regards to the ''Maximum Allowable Revenue'' for the five-year period starting in April. Vector will also be reviewing its expenditure plans, to ensure funds are being allocated to projects that offer the best return for shareholders.

Vector has assets outside those regulated by the Commerce Commission, but these make up a smaller part of the business. When the Commerce Commission last updated its Default Price-quality Path in 2014, Vector responded by maintaining its dividend payout.

Vector has seen an ongoing decline in share price over the past few weeks in the lead up to its results. This is not uncommon, as investors position themselves ahead of the release.

Spark Limited will be reporting on the 19th. Shareholders will be taking careful note of two particular areas, being its services arm and its platform for streaming.

Spark has made little secret that it sees wireless internet and 5G as the target areas for the company to grow. Moving away from copper lines to wireless offerings gives Spark the opportunity to target more customers while potentially lowering its initial input costs.

Spark also sees growth coming from customers wanting larger data allowances. This has been an ongoing trend for many years across every single OECD country, as people wish to view more data-intensive content, such as videos, at their leisure.

Its platform for streaming will be topical, as it re-evaluates its future in this space following the sale of Lightbox to Sky Network Television. Spark Sport appears to have passed the litmus test of the Rugby World Cup, and can now be considered a proper competitor to Sky TV's offering. The public is now familiar with its product, and has some faith in its capacity to deliver content.

EBOS Group will report on the 20th, one week from today. EBOS hs previously indicated that the report will show an improvement on the previous year, as strategic acquisitions begin to make meaningful contributions to its bottom line.

EBOS is currently sitting on a large war chest of available capital and may be about to publicly announce whether it will be used for further acquisitions.

Reporting season is an important period for investors as it allows them to review their investments and ensure the company is tracking the right direction.

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Those who have reported already include Sky City Entertainment, Contact Energy and Sky Network Television.

Sky City's result saw a small uplift in share price, perhaps reflecting a market that was bracing for worse news than it saw.

The dividend was maintained, leaving it paying a gross yield of about 7.7% based on current prices. It anticipates paying another 10 cents September, and expects this dividend to grow following the completion of the major projects currently underway.

The headline result was strong, reflecting the sale of its car parking facilities last April for $220 million. Normalised profit was lower, and earnings per share have fallen.

Following the disastrous fire of October last year, Sky City shareholders have been awaiting further details around the adjusted timeframe for this project to complete. This news seems imminent, with Fletchers expected to update the market within a fortnight.

The impact of the Coronavirus is also mentioned – albeit simply to advise that Sky City has observed some cancellations, and weakness around its portfolio of casinos in terms of visitor numbers. This is about as much news as shareholders could hope for at this stage.

Contact Energy's result was fairly well received by the market, with the share price climbing sharply. Although its profit was down, this was broadly anticipated by both Contact and the market as the previous year’s result had been particularly strong, mostly due to its hydro generation.

Contact maintained its dividend of 16 cents for the half year, representing a dividend yield of about 6.5% gross if the full year dividend is similarly maintained.

Longer-term, there does seem to be some potential for modest growth in its dividends. Its Tauhara development, a geothermal generation plant near Taupo, appears to be progressing well, and will represent a low-cost option to supply electricity to the North Island.

While there remains some lingering doubt around the sector with regards to the New Zealand Aluminium Smelter at Tiwai Point, recent signals seem to suggest this issue will see a resolution that is favourable to the sector.

Reports are suggesting the Electricity Authority, a Government owned entity, may open a path to allow the NZAS to reduce its transmission charges, effectively passing those costs on to other consumers. Meridian Energy, half owned by the Crown, has already made it clear it is willing to cede ground in terms of actual electricity costs.

Previous comments on the Tiwai smelter issue generated a strong response – almost universally opposed to the idea of providing either a direct or indirect Government contribution. These hopes may be in vain, as both market pricing and comments to media have suggested this may be inevitable.

For Contact Energy, a long-term solution which includes the continued operation of the smelter will almost certainly be in its best interests. The electricity sector will be very welcoming of certainty around demand, to allow for better planning for supply as our population increases.

Sky TV's result, by comparison, was not well received.

Although the share price climbed sharply immediately after the release, the result would charitably be described as ''below expectations''. I note that the share price eventually did fall, perhaps as people had a chance to digest the result.

Revenues are falling while costs are rising – the exact opposite to what shareholders were hoping to see. While customer numbers are rising, the growth has largely been seen in its lower-cost streaming option, as more people abandon the higher-revenue satellite product. The rate of departure from this product is slowing, perhaps signalling that it is finding a base level of people happy to continue as customers. The cost increases include some one-offs, such as redundancies and consultancy fees.

The bigger issue for Sky TV remains the cost of programming rights. Shareholders will be wanting to see whether the hundreds of millions spent on securing these rights, for content ranging from rugby to reality TV, are leading to actual revenue growth. Shareholders will already be aware of the fierce competition it has faced from other industry players, including Spark. Consolidation in this sector would be welcomed by Sky TV shareholders.

Similarly, shareholders will be hoping to see value from the decisions on sponsorship, specifically its decision to acquire the naming rights of the Wellington Regional Stadium, colloquially known as the Cake Tin. Sky TV has made a concerted effort to prime its audience for some further developments in this space, to further integrate live sport viewers with the Sky platform.

In terms of revenue, Sky TV has been caught up in a global trend of falling advertising revenues, and will likely be distancing itself from ambitions to tackle this market. Media across all channels are finding similar trends, and there seems little likelihood that the trend will change course.

Sky TV has made no secret that its ambitions are long-term, as it belatedly adapts to an audience that is perhaps more time-poor than previous generations, and is more likely to view their content on the small screen, than the big screen. It must also tackle piracy, a seemingly unsolvable issue for content providers.

Sky TV notes that ''the path ahead is not an easy one'', and it foresees ''a significant increase in content costs''. Shareholders hoping for a quick turnaround will likely be disappointed. The comment that Sky TV will ''require a strengthened capital structure'' also tends to suggest that serious changes may be coming to its balance sheet.

Readers will recall that NZ Rugby recently acquired 22 million shares at 92 cents, as part of its deal with Sky TV for programming rights. This was approximately three months ago. The shares are worth about a third less today.

NZ Rugby will not see itself as a short-term shareholder. Its concern will be focused on the trajectory of the company, not its quarterly share price performance.

Shifting a corporate strategy from one focussing on sales and short-term growth, to one focussing on balance sheet strength and long-term growth, is not without risk. It is crucial that shareholders buy in to the strategy and adopt a long-term mindset. It's also important to see continuity within the leadership team and avoid improper incentives.

One of the best examples of long-term strategic planning would be Mainfreight, which has consistently illustrated a willingness to postpone short-term objectives in favour of long-term sustainability, carefully utilising capital to maximum effect.

The risk with such an approach, of course, is that shareholders lose confidence and patience in the ability of the company to deliver on such ambitions.

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Synlait Milk's guidance update, released Thursday morning, sent the share price tumbling back to levels last seen in 2018.

It expects profit to fall, impacted primarily by reduced sales in China. This impact is unrelated to Coronavirus. The effect of that, if any, will be seen in future releases. Synlait has widened its forecasts to account for the uncertainty around the impact of the disease.

Synlait reports to the market, in full, on the 19th of March.

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Following a full-year result that revealed a huge fall in profit, AMP's decision to increase the short-term incentive package for its new CEO is baffling to me.

Francesco De Ferrari, in his second year in the job, is paid a base salary of more than two million dollars. His total incentive package is many millions more.

This comes against the backdrop of AMP's own shareholders launching multiple class actions against the company over the past year, while another litigation funder announced today its intention to launch yet another class action.

It also follows an earlier adjustment of his overall package, which lowered the hurdles required to qualify for the incentive package.

While I accept that today's announcement of an increase to his incentive package is not material to the company, one has to wonder if this is necessarily the best action to take when shareholders are venting their collective fury at the company.

Shareholders must surely hope that he has now been sufficiently incentivised to complete the task afforded to him.

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The Reserve Bank has held the OCR at one percent.

After a period of hope of an uptick in inflation and growth, the Coronavirus situation extinguished this as the market began to ponder the logic of a rate cut, similar to those seen globally in the wake of the SARS virus in 2003.

Throughout cities in China, stated infections and deaths continue to mount, as the Chinese government takes dramatic steps to limit the spread of the disease, including severe restrictions on freedom of movement.

The Reserve Bank clearly see the current predicament to be short-term in nature. One hopes they are correct.

TRAVEL:

David Colman will be in Lower Hutt on 19 February, Palmerston North on 26 February, and in New Plymouth on 27 February.

Mike will be in Auckland on 25 February, Hamilton on 26 February and Tauranga on 5 March.

Edward will be in Nelson on 4 March, in Auckland (Albany) on 11 March and Auckland (Mt Wellington) on 12 March.

Johnny will be in Christchurch on 25 March.

Chris Lee

Managing Director

Chris Lee & Partners Limited

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Taking Stock 5 February 2020

(Distributed Wednesday as Thursday is a public holiday)

AS if global debt, changing climate, and inequality were not enough to contemplate, those who make investment decisions must now direct a thought towards a virus that could be fatal and certainly will disrupt the global economy.

Those who position themselves as worldly, omniscient masters of the universe might argue that health issues are simply a short-term challenge to be overcome by science.

Others might posit that over population of our planet inevitably is threatened by plague or famine.

However for many, the Coronavirus represents another threat of unknown dimensions, and feeds the fear gene that kick starts our self-preservation plans.

Our business began to observe this response last month.

Some reacted by reducing their holdings in specific shares in companies that clearly are at risk of lower revenue. The most obvious example might be Air New Zealand.

Some reacted by monetizing some of the extraordinary gains that were justified only if the years ahead encounter no meaningful setbacks. Commonly this involved selling perhaps 10%, maybe 20%, of the holdings in a star-studded portfolio.

The reaction I did not see was a complete capitulation to fear, selling all equities, accepting capital preservation at the cost of meaningful income.

I might not have observed that, but it surely was a tactic considered by the most risk averse. Indeed such logic led last year to fund managers, like Pie, Milford & Aspiring, cashing up large chunks of equities, though none were as unwise as the Royal Bank of Scotland who abandoned equities three years ago.

Perhaps it was that fear that led last week to a new level of questions about fixed interest securities with higher yields.

Obscure, and in my opinion unusable, issuers, like Alpha, General Finance and FE Investments, were all raised as potential providers of regular income to replace the dividend providing shares of NZX-listed companies.

My response to enquiries about switching to finance companies was unsupportive.

I will share my logic.

In summary, I would rather endure the share price volatility of, say, Meridian Energy, and take the risk of reduced dividends (sparked, say, by the closure of Tiwai Point) than to invest in any privately-owned finance company, irrespective of its published, audited, regulated, even credit-rated, financial statements.

The following is my explanation.

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Any finance company wishing to raise money from the public, at any efficient level (say $50 million) must by law have its documents approved by the Companies Office, which sits within the Ministry of Business, Innovation and Employment (MBIE).

To win clearance, it must have a declared minimum level of capital, it must provide a trust deed, it must have its trust deed supervised by a licensed trust company, and it must have fit and proper directors and executives. It will be regulated by the Reserve Bank of NZ.

It must be audited by a licensed auditor.

It must update its financial performance regularly and accurately.

Its advertising must meet standards of veracity.

It will be subject to the Financial Markets Conduct Act.

If it encounters problems and falls into receivership or liquidation, that function must be provided by a licensed insolvency practitioner.

Does this sound like a defence system designed to ensure investors are protected from all but simple business risk?

It would sound reasonable if each of the defence systems were efficient and transparent.

They are not.

Worse, the rules are still patchy, the definition of fit and proper people remains loose, the trust deeds are still contractual rather than dictated by statute and the remedies for failure are still not consistent. Thus accountability is still uncertain.

The start point is the ownership and governance.

Here the problem is the unpublished and unproven criteria by which the Reserve Bank will test for fit and proper compliance.

What are the criteria? Who gets consulted in the testing process? Is the process visible? Do we get to observe a list of those regarded as unfit and improper? Do the referees have street smarts?

Does integrity and morality enter the judgement?

The second step for a finance company is to prepare a trust deed and reach a contractual agreement with a licensed trustee.

Does the regulator pre-approve the deed before it is marketed to a trust company? Are there standards and rules that are obligatory to include in the deed? Is the deed readable and permanently visible? Are the trust companies able to employ streetwise, experienced, committed people with the authority and motivation to blow the whistle?

Does the deed define what is real capital, define its lending, and commit to displaying its cashflow forecasts in a form that is regulator-approved?

The third step is the management.

Are they experienced in finance company moneylending? Do they have any right to perform related-party lending? Do they communicate honestly with all parties? Does accountability govern their behaviour?

The fourth step is regulatory supervision.

Is the Companies Office functional, staffed with experienced streetwise people, or is it effectively run by contracted private sector lawyers with, or without, personal experience of running moneylending organisations? Is there a forensic inspection capacity?

We know the Financial Markets Authority has beefed up, in terms of resources, and hopefully skilled staff, but is it the team at the accident or the team to prevent an accident?

I have some hope, but the FMA needs both the money and the skilled staff to perform its tasks. Is it to be granted the money needed to acquire the staff? And are there enough skilled staff available for such a crucial function?

So far, all these questions may be regarded as rhetorical. The answers are obvious.

Do not expect me to have faith in the last step, the quality and skills of our insolvency practitioners.

There will be some experienced, well-meaning people in this area but the practices and processes are weighted against investors and are in urgent need of reform. The opportunity to reform arose last year but an insipid MBIE colluded with an Old Boys Network to produce a new Insolvency Practitioners Act that will do nothing to alter the balance of power. I view it as a disgraceful piece of law. I am delighted to note that the Chief Justice Helen Winkelmann is also concerned about access to justice for civil claims, as is the Minister of Justice, Andrew Little

Insolvency practitioners will continue to have unfettered power. They are not required to be supervised by independent people.

Unsecured creditors or second-ranking creditors will rarely, if ever, be treated with the same respect as first-ranking secured creditors, under the current law.

Why? Laziness and self interest. Paid for by the secured creditors, the high and unmonitored fees paid to the insolvency practitioners, the lawyers who feed off carcasses, the bankers who charge ''penalty'' fees and the trust companies, which also collect unmonitored fees, are almost never examined in court.

The last defence for finance company investors and those whose secured loans have failed, is in the hands of a system that feeds only one powerful group, the banks or the secured lender, and the lawyers and trustees.

So what hope does an investor in a finance company have?

My book The Billion Dollar Bonfire, describes how all these so-called protections for investors were not worth a tin of Heinz beans.

Anyone pondering the use of any finance company should read the book. It will be in libraries as well as in most book shops.

Reading it should be a compulsory first step for potential finance company investors. That is the purpose of my publishing an electronic version, which should appear in coming weeks, on Amazon.

Investors seeking fixed returns from capital-stable products should restrict their options to the listed bonds issued by companies that will have higher capital levels and be subjected to more skilled market scrutiny than that provided by discredited trust companies.

I regret that our politicians, of all hues, have no motive to fix the problem, nor have they displayed the courage or personal convictions to want to fix it. Their solution is caveat emptor. Buyer beware. 

The politicians remind me of amoebae.

The only finance company securities I would trust in the current environment are those owned by large institutions that themselves have the moral, if not legal, obligation to behave transparently and wisely.

Fisher & Paykel Finance was such an example, as was UDC. Both have been closed to investors.

So let us not forget Bridgecorp, St Laurence, Capital & Merchant Finance, Hanover, First Step, Strategic Finance, Dominion Finance, Lombard, MFS, Nathans and the 50 other finance companies that stripped investors in the previous decade. Dishonesty was not necessarily omnipresent, but it was widespread.

The directors, the owners, the executive, the trustees, the auditors, the regulators, the credit-raters, the Companies Office, even the inept NZX at that time, the insolvency practitioners and the Crown were rarely examined and almost never made accountable.

I will speak up when I find that the environment has changed sufficiently to make the sector a realistic option.

It will need the alignment of many new stars and planets to overcome my extreme disrespect for the politicians and MBIE, for not addressing the issues.

New Zealand needs second-tier lenders but under the current regime investors should not be the source of the funds.

Read the book. The facts are undeniable.

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TRUST deeds are simply a so-called rule book, providing the boundaries within which directors and executives must operate.

A trustee simply monitors operations to ensure all behaviour is permitted by the deed. Often in the past the inept trustees just asked the directors for a certificate confirming compliance. There was not even a cursory inspection.

The theory sounds credible, but rarely is there any accountability.

Deeds have been ambiguously and deceptively written for decades, and dreadfully managed in the last 15 years, by men and women also with amoeboid characteristics.

Consider this, an admittedly old case, but one that arose from a bad trust deed.

In the 1970s a permanent building society hired commission salesmen to sell shares in its operation, promising access to mortgage finance for those who signed up to its regular savings programme to buy the shares.

Tucked away in the deed was a clause designed by a deceptive lawyer, which disclosed that anyone who missed a regular contribution forfeited his shares. Effectively the forfeited shares went to the manager of the organisation. By my definition the recipient was permitted by the deed to steal. The amount involved was millions.

The marketing occurred in low socio-economic areas where access to professional advice was scant, meaning the deceptive deed was rarely read, and probably never discussed by the salesmen.

A lawyer and a few managers must have benefitted by millions. Savers lost their money the moment they missed a contribution date.

How could such a deed have been allowed by the law? The law was never consulted.

I often ask questions of those who invest in securities subjected to a trust deed, overseen by a trustee.

Have you read the deed?

Is the trustee competent, let alone committed to investors, rather than incompetent and committed only to those who pay his bills?

For the last ten years, those questions have made obvious the correct investor response.

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AN equally scary truism is the invisibility of management contracts that can materially affect the outcome to investors.

Lloyd Morrison's issue of Infratil shares took place in 1994. The management contract awarded to his company Morrison & Co would have been disclosed or at least supplied to interested parties.

I invested at the beginning, but do not believe I saw, and confess that I certainly did not read, the management contract that defined Morrison & Co's rewards, comprising significant annual fees and as we now know, life-changing potential bonuses.

I have been amply rewarded by Infratil's successes. Morrison & Co have been lavishly treated, also.

The odd dud investments – UK & European airports and Retire Australia as examples, and the odd error of analysis, like not investing in Wairarapa Electricity – have been offset by the occasional inspired investments, such as the holding in the data protection company in Australia, the current portfolio star.

Of course we investors now accept that the management contract, still never read by me, allows Morrison & Co to appoint a valuer to opine on the value of any unlisted assets, and accept that theoretical value as the basis for a Trump-like share of unrealized, valuer-decided capital gains.

I am fairly sure no retail buyer of Infratil shares in the last 25 years has asked us to obtain and publish the contract.

My point here is that crucial documents like trust deeds, management contracts, even executive contracts, are relevant documents and ought to be visible on websites and republished or at least summarised in annual reports.

Morrison & Co captured more then $100 million of bonuses in the last year, off an investment that if sold at theoretical valuation, or milked perpetually, may deliver immense gains for shareholders, notwithstanding the tariff claimed as a bonus for the obviously clever work also rewarded by impressive annual fees. (The bonus has a present day value; investors will see their reward over time. Is the bonus refundable if the ultimate value falls?)

Transparency of all relevant documents – and I do not mean just availability on request – leads to an informed market able to make informed decisions.

Sadly Lloyd Morrison died of leukemia some years ago.

He did believe in transparency and an informed market.

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Travel

I will be in Christchurch on February 18 (pm) at the Airport Gateway Motor Lodge, Roydvale Ave, and have times available at 2:30 and 3pm.

David Colman will be in Lower Hutt on 19 February, Palmerston North on 26 February, New Plymouth on 27 February and in Kerikeri on 6 March.

Mike will be in Auckland on 25 February, Hamilton on 26 February and Tauranga on 5 March.

Edward will be in Nelson on 4 March, in Auckland (Albany) on 11 March and Auckland (Mt Wellington) on 12 March.

Johnny will be in Christchurch on 25 March.

Chris Lee

Managing Director

Chris Lee & Partners Limited

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